The European Central Bank leapt into action to kickstart the eurozone economy with unprecedented rate cuts today as fears grow over the threat of deflation in the single currency bloc.

The ECB cut its key interest rate from 0.25 per cent to 0.15 per cent and moved its deposit rate into negative territory, to -0.10 per cent from zero - which means it is charging banks for holding their cash.

The move had been expected after growth in the eurozone came in at
just 0.2 per cent in the first quarter and inflation fell to 0.5 per
cent in May. That was down from 0.7 per cent in April and well below the ECB’s target of 2 per cent.

The Bank of England has kept the benchmark 'bank rate' at its record low of 0.5 per cent since early 2009.

It stopped short of large-scale asset purchases known as quantitative easing for now, but ECB President Mario Draghi said more action would come it necessary.

Draghi outlined a four-year €400billion (£325billion) scheme giving banks that have been holding back credit due to looming stress tests an incentive to increase lending to businesses in the eurozone.

'Now we are in a completely different world,' Draghi told a news conference, citing 'low inflation, a weak recovery and weak monetary and credit dynamics'.

Howard Archer, chief UK and European economist at IHS Global Insight, said the ECB action was 'thoroughly justified by the mounting risk of persistent very low eurozone inflation morphing into deflation'. The reduction by 0.1 per cent 'may be seen on the tentative side', he said.

He added: 'Despite being widely anticipated and in some quarters criticised for occurring too late, it is still a bold and unusual move by the ECB to take its deposit rate into negative territory. '

But Schroders European economist Azad Zangana argued against the deposit rate cut.

'We expect banks to simply pass on the costs to households and businesses, either by charging fees for savers, but more likely through higher interest rates on new borrowers - the opposite of what the ECB is trying to achieve.'

Carsten Brzeski of ING Bank said the ECB had 'entered unchartered new territory in its quest to support the eurozone economy'.

Deflation threat: European Central Bank President Mario Draghi has taken action as the eurozone economy stumbles

'Will it
help to kick-start the economy? Probably not, but at least it
demonstrates the ECB's determination and ability to act,' he said.

Figures published by Eurostat this week suggested a fragile rebound in
the eurozone, mainly driven by Germany’s solid 0.8 per cent growth,
which offsets stagnation in France and the shrinking output in Italy,
the Netherlands, Portugal and Finland.

The pound edged up against the single currency at 1.23 euros.

Former
Bank of England official Andrew Sentance tweeted that it could reach
1.25 euros by the end of the month if minutes of today's monetary policy committee meeting showed a vote for higher rates.

The MPC held interest rates at 0.5 per cent yet again today
as it contemplated an increasingly healthy UK economy.

Strong services
data yesterday led to speculation that one policymaker might have called for a rate rise, but that will only be revealed with the minutes in a fortnight's time.

Martin Beck at the EY ITEM Club said that the era of unanimity among MPC members may be coming to an end.

'All eyes will now be on the meeting of the Financial Policy Committee on 17th June,' he said. 'With recent data offering mixed messages on whether the housing market is heating up or cooling down, intervention by the FPC to dampen house price growth is not guaranteed.

'But any action by the FPC - perhaps the imposition of additional capital requirements on high loan-to-income mortgages - will reduce pressure on the MPC to consider a rate hike.

'At the
very least, the MPC will want to give time for any macro-prudential
measures to take effect. What’s more, if the ECB decides later today to
loosen monetary policy in the euro-zone, upward pressure on sterling is
likely to grow, tightening monetary conditions in the UK and pushing
down inflation.

Activity in the services sector was strong in May, suggesting the UK economy will grow strongly this summer

'So
despite our expectation of continued strong economic growth and falling
unemployment, a rate hike still looks unlikely until well into 2015. A
split vote on the MPC may emerge sometime in the next few months, but
the Committee’s hawks are set to remain in a minority for some time to
come.'

A
strong UK growth outlook has raised suspicions that the MPC will be
forced to raise rates well before spring 2015, which had been previously
flagged up as likely by the Bank itself among others.

Data from Markit yesterday showed services
companies - which include everything from financial firms to restaurants
and make up three quarters of UK output - took on staff at the sharpest
rate in 17 years in May.

The purchasing managers’ index fell
slightly last month to 58.6 from 58.7 in April - which was the strongest
reading in 2014 so far, remaining well above the 50 mark that indicates
growth.

Alan
Clarke of Scotiabank said the combined reading from all sectors was
'consistent with very solid GDP growth into the middle of the year at
least'.

He said that in the past this was a
level that 'would have been screaming out rate hikes' but that wage
growth and higher inflation remained weak - but an improvement in these
could mean that 'a hike is possible this side of Christmas'.

The
UK economy grew by 0.8 per cent in the first quarter, its fastest
annual growth in more than six years, and economists said they expected
it grow again by 0.8 per cent in the second quarter, coming back to the
levels seen before the financial crisis in 2008.

PMI services employment index: Firms took on staff at their fastest pace in 17 years in May

The
buoyant services PMI follows similar upbeat manufacturing and
construction reports and adds to pressure on the Bank of England to
raise interest rates, which have been at their historic low of 0.5 per
cent since early 2009.

Markets
expect rates to start to gradually rise from early 2015, but some
economists are calling for a rate rise later this year.

Williamson
said: ‘With every strong PMI reading, the more lively the discussion
will become among the Bank of England’s Monetary Policy Committee that a
pre-emptive early hike in interest rates is warranted.

‘However, with inflationary pressures remaining subdued, the case for higher rates is by no means clear cut.

‘Higher wage growth is starting to follow the labour market upturn, but
until substantial increases in pay rates materialise in the official
data, the chances are that the Bank of England will keep its foot firmly
on the accelerator pedal to help keep the economy booming.